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Dynamic Risk Modeling Handbook
CAS Dynamic Risk Modeling Working Party
James E. Rech, co-chair
Run Yan, co-chair
Amin Munza
Yang Bin
Russ Bingham
Peter V. Burchett
Steven J. Groeschen
Krisan Haria
Turab Hussain
Michael R. Larsen
Alex Lu
Atul Malhotra
Jonathan Neuberger
Raju Bohra
David Ruhm
Mark R. Shapland
Schyler Thiessen
Ryan Tse
Xueli Wang
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Abstract
Motivation. The CAS Dynamic Risk Modeling Committee, and its predecessor the CAS Dynamic
Financial Analysis Committee, have long recognized the need for reference materials related to risk
modeling. Over the years, these committees have sponsored calls for papers on different topics related
to risk modeling, resulting in many excellent papers. However, there is still a need for a cohesive
document that ties the basic concepts from these papers together in one source and adds practical
examples for students and practitioners alike.
Method. The Dynamic Risk Modeling Working Party utilized several existing works (cited in the
Acknowledgements) and surveyed the existing literature. An outline for the overall document was
created and individuals on the Working Party were assigned to each section, with the goal of reorganizing the existing work, adding new material and re-writing as necessary in order to create a
complete set of documents.
Results. The Dynamic Risk Modeling Handbook is contained in a series of 12 documents, this being
the first document and the other 11 as separate chapters and appendices of the Handbook.
Corollary. For many of the examples in these documents, the Working Party worked closely with the
Public Access Model Working Party which created corresponding “worked” examples in the Public
Access Model. References to the “worked” examples are cited in these documents, but the “worked”
examples are part of the work product of the Public Access Model Working Party.
Availability. All of the Dynamic Risk Modeling Handbook documents are available in PDF format on
the CAS website at ________________________________. The documents have also been
published as part of the __________________.
Keywords. Dynamic Risk Modeling, Dynamic Financial Analysis, ...
PREFACE
Dynamic Risk Modeling (DRM) is the process by which an actuary analyzes the financial
condition of an insurance enterprise, or a portion of an insurance enterprise. Financial
condition refers to the company's future operations through an unknown future
environment and can include the ability of the company's capital and surplus to adequately
support those operations.
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The purpose of this Dynamic Risk Modeling Handbook is to provide suggestions and
guidance to actuaries in performing DRM studies. As such, the Handbook is not a Standard
of Practice and is not binding upon any actuary. Nor is the Handbook intended to define an
acceptable standard of care which, if not followed, would indicate the actuary has acted
negligently. Rather, the Handbook provides a list of considerations for actuaries to refer to
when performing DRM. The Handbook is not exhaustive, but is intended to be revised and
edited regularly as knowledge of DRM evolves. The release date of the Handbook appears
on the cover page of the document, as well as at the top of each page.
The Handbook does not prescribe reporting requirements regarding DRM. The actuary
performing DRM should decide on the format of any required report and comply with
regulatory or professional requirements regarding such reports. The report allows the reader
to clearly determine the key material threats to the company's future operations. For
example, the report could assist in quantifying the company's surplus over the projection
period and allow the reader to better understand the impact of alternative business scenarios
on surplus. This report would not be an absolute statement regarding the financial condition
of a company, but rather a tool to identify material risks to solvency faced by the company.
In addition to assisting management and regulators with understanding solvency risks, the
DRM process generally permits management to gain a better understanding of both the risks
and opportunities inherent in the company under various business conditions and stress
factors. This understanding allows management to better control the company's risk profile
and to allocate surplus more effectively and efficiently. It also allows management to test the
impact of various proposed business strategies under a variety of possible future conditions.
The Handbook does not prescribe a specific projection period for the entire process of
analyzing the company's future operations. The length of the projection period is generally
determined by either the management, the actuary performing the testing, or the regulators.
However, if a long projection period is used, the actuary must use greater care in choosing
assumptions and generally test a broader array of assumptions.
The process of DRM involves testing a number of adverse and favorable scenarios
regarding an insurance company's operations. DRM can assess the reaction of the company's
surplus to various selected scenarios. This assessment of the test results is contained in the
DRM report. The Handbook does not present the scenarios to be used in the testing
process. Normally, however, the company's business plan will serve as the base scenario for
this process. The choice of additional scenarios is determined by management discussion,
actuarial judgment, and/or regulatory guidance. Scenarios may vary greatly depending on an
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individual company's circumstances.
The actuary is expected to select a set of plausible scenarios sufficient to test most
material threats to the company's future operations. For example, it is expected that an
actuary performing solvency testing will focus most heavily on those scenarios for which a
material adverse impact on surplus is plausible. The reporting actuary, therefore, should
define plausible scenarios and a materiality standard. By definition, large balance sheet items
like loss reserves, unearned premium reserves, invested assets, and other material receivables
and payables, as well as future profitability, should be tested under various scenarios.
Influences such as pricing strategy, reserving methodology, reinsurance arrangements,
growth targets, and investment policy should be analyzed. Items the actuary reasonably
believes to be relatively immaterial, such as a slightly higher than average broker commission
level, need not be addressed. It may be interesting to management, but if the situation is not
likely to impair solvency, or materially impact profitability, then it need not be rigorously
tested.
In performing DRM, as in any actuarial analysis, the actuary should assess the credibility
of the data used to perform the analysis. If the data is not credible, the actuary should
augment it with external data sources. Indeed, many of the potential threats to the solvency
of a company are external, and the actuary should gather information from many external
data sources, such as information on the economy, reinsurers, and emerging environmental
risks. Each actuary performing DRM should assess the reliability and quality of each
company's management information systems and policy information systems. This can
become complicated if a company owns many subsidiaries, particularly in foreign or nonU.S. locations. To properly analyze the future operations of a company with subsidiaries,
each subsidiary should be analyzed separately.
The actuary preparing the DRM report may choose to rely on the work of another
professional. Such professionals include auditors, both external and internal, investment
professionals, insurance company senior management, and other actuaries who have
expertise in areas that may be useful to the actuary preparing the report. Any actuary who
relies on another professional should establish a basis for doing so. In addition, the actuary
should formally communicate the significance of the process to those professionals whose
advice is to be included in the report, so the professional is aware of and understands the
significance of their contribution.
To properly assess the financial condition of a company, the actuary should have access
to all relevant documents, systems, and employees. This Handbook, does not grant authority
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for that access. The actuary should look to the regulatory body of the jurisdiction requiring
the DRM for access to those areas, or to the company's senior management if the analysis is
being performed for internal purposes.
When an actuary identifies one or more plausible scenarios as a material threat to
solvency, the actuary should suggest possible corrective actions or control strategies. Further
action steps that may be required, such as possible notification of regulators, external
auditors, or audit committees of boards of directors, are beyond the scope of this
Handbook.
Intended Audience
Need to add…
The Actuary’s Changing Role
Historically, casualty actuaries have primarily focused on rates and loss and loss
adjustment expense reserves. Since 1980, property-casualty actuaries have had increasing
responsibility to provide statements of actuarial opinion on the loss and loss adjustment
expense reserves of property-casualty insurance companies in the U.S.
In more recent years, regulatory and competitive pressures, as well as the desire for a
broader understanding of the insurance process, have led and continue to lead to expansion
of the casualty actuary’s role. To meet the demands of this expanded role, actuaries now
need a more complete understanding of insurance company cash flows; both assets and
liabilities and their associated risks as well as their interrelationships.
This broader role will also increase the number of situations where the actuary must
function in an interdisciplinary setting, communicating with the other major functional
specialists of a company – those in investments, underwriting, claims, accounting and
finance. This will bring new challenges for what is “normal” in terms of language or
quantitative measures for the individual specialties which may need to be described or
measured differently for purposes of the dynamic risk model. However, if done effectively,
this interdisciplinary communication network among specialists, and ultimately the
company’s management, can be one of the most valuable end results of building a dynamic
risk model.
Main Features
The main features of these documents …
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Professional Perspectives Boxes
Need to add…
Contemporary Perspectives Boxes
Need to add…
Integrative Problem Material
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Chapter Summary
The Dynamic Risk Modeling Handbook documents are organized as separate chapters
that combined constitute the entire Handbook. The individual chapters are organized as
follows.
Chapter 1: Introduction to Dynamic Risk Modeling
The purpose of Chapter 1 paper is to discuss and provide guidance on the important
issues and considerations that confront the practitioner when designing, building or selecting
dynamic risk models of property-casualty risks.
Chapter 2: Overview of Dynamic Risk Modeling
The purpose of Chapter 2 is to provide an overview of Dynamic Risk Modeling (DRM)
and its usage in a property-casualty insurance context. It highlights the evolution of financial
modeling from static financial planning to DRM, presents some potential uses for DRM
models and provides a few cautions about the use of such models.
This document is intended to serve two purposes: first, as a non-technical overview for
interested parties and second, as an introduction to the comprehensive rewrite of the
Dynamic Risk Modeling Handbook.
Chapter 3: DRM Strategies
Need to add…
Chapter 4: Scenarios
This chapter focuses on the components and issues involved with the scenarios to be
considered in a DRM application. Because of the interplay between models, scenarios,
variables, and data, comments are provided on each topic, but the focus is on scenarios.
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Chapter 5: Asset Modeling
Need to add…
Chapter 6: Pricing / Reserving Modeling
Need to add…
Chapter 7: Performance & Risk Measures
Need to add…
Chapter 8: Coherent Measures of Risk
Need to add…
Chapter 9: Presentations of DRM Results
Need to add…
Appendix A: Checklist of Considerations for the DRM Modeling Process
Need to add…
Appendix B: Glossary of Terms
Need to add…
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Acknowledgments
The Working Party members gratefully acknowledge the guidance and leadership of the CAS Dynamic Risk
Modeling Committee (DRMC), which sponsored this effort on behalf of the Casualty Actuarial Society and
peer reviewed the documents. The DRMC members include:
Mark R. Shapland, chair
Shawna S. Ackerman
Craig A. Allen
Fernando Alberto Alvarado
Nathan J. Babcock
Peter V. Burchett
Thomas P. Conway
Patrick J. Crowe
Karl Goring
Richard W. Gorvett
Larry D. Johnson
Michael R. Larsen
Glenn G. Meyers Ph.D.
Timothy J. Pratt
James E. Rech
Chester John Szczepanski
Justin M. Van Opdorp
Run Yan
The Working Party member assignments and contributions to the Handbook are as follows:
PREFACE:
James E. Rech, leader
Mark R. Shapland
CHAPTER 1:
Mark R. Shapland, leader
CHAPTER 2:
James E. Rech, leader
CHAPTER 3:
Run Yan, leader
Munza Amin
CHAPTER 4:
Mike Larsen, leader
CHAPTER 5:
Schyler Thiessen, leader
Munza Amin
Krisan Haria
Alex Lu
Jonathan Neuberger
James E. Rech
Ryan Tse
CHAPTER 6:
Steven J. Groeschen, leader
Munza Amin
Raju Bohra
CHAPTER 7:
Ryan Tse, leader
Munza Amin
Peter V. Burchett
Krisan Haria
Alex Lu
David Ruhm
CHAPTER 8:
Ryan Tse, leader
Peter V. Burchett
Krisan Haria
Alex Lu
David Ruhm
CHAPTER 9:
Raju Bohra, leader
Turab Hussain
The Working Party members also gratefully acknowledge the existing documents which formed the basis
for large parts of the Handbook and the individuals that contributed to those documents:
DYNAMIC FINANCIAL ANALYSIS HANDBOOK
This handbook was first published in September 1995. It was prepared by the Dynamic Financial Analysis
Subcommittee of the Casualty Actuarial Society. The subcommittee members included:
Susan T. Szkoda, chair
Kathleen M. Holler
Casualty Actuarial Society – Dynamic Risk Modeling Handbook
Liam M. McFarlane
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Frederick F. Cripe
Roger M. Hayne
Jeffrey P. Kadison
Stephen J. Ludwig
Stephen T. Morgan
Richard W. Nichols.
The Working Party used parts of this document for…
OVERVIEW OF DYNAMIC FINANCIAL ANALYSIS
This paper was dated June 16, 1999 and was prepared by a subcommittee of the Dynamic Financial
Analysis Committee of the Casualty Actuarial Society, under direction of the full committee. The
subcommittee was comprised of:
Gerald S. Kirschner, leader
Mark R. Shapland
William R. Van Ark
Gerald S. Kirschner
Pierre Lepage
Eduardo P. Marchena
Glenn G. Meyers, Ph.D.
Raymond S. Nichols
Marc B. Pearl
Mark R. Shapland
William R. Van Ark
Thomas V. Warthen
Peter G. Wick
The committee was comprised of:
Charles C. Emma, chair
Donald F. Behan
Roger W. Bovard
Richard Derrig
Owen M. Gleeson
Philip E. Heckman
The Working Party used major portions of this document for Chapter 1.
DYNAMIC FINANCIAL MODELS OF PROPERTY-CASUALTY INSURERS
This “chapter” was first published in the 2000 CAS Winter Forum. It was prepared by a subcommittee of
the Dynamic Financial Analysis Committee of the Casualty Actuarial Society, under direction of the full
committee. The subcommittee was comprised of:
?
The committee was comprised of:
Charles C. Emma, chair
Donald F. Behan
Roger W. Bovard
Richard Derrig
Owen M. Gleeson
Philip E. Heckman
Gerald S. Kirschner
Pierre Lepage
Eduardo P. Marchena
Glenn G. Meyers, Ph.D.
Raymond S. Nichols
Marc B. Pearl
Mark R. Shapland
William R. Van Ark
Thomas V. Warthen
Peter G. Wick
The Working Party used parts of this document for this Preface, Chapter 1 and …
DYNAMIC FINANCIAL ANALYSIS: STRATEGIES
This “chapter” was first published on June 20, 2000. It was prepared by a subcommittee of the Dynamic
Financial Analysis Committee of the Casualty Actuarial Society, under direction of the full committee. The
subcommittee was comprised of:
Roger W. Bovard, leader
?
The committee was comprised of:
Charles C. Emma, chair
Donald F. Behan
Roger W. Bovard
Richard Derrig
Owen M. Gleeson
Philip E. Heckman
viii
Gerald S. Kirschner
Pierre Lepage
Eduardo P. Marchena
Glenn G. Meyers, Ph.D.
Raymond S. Nichols
Marc B. Pearl
Mark R. Shapland
William R. Van Ark
Thomas V. Warthen
Peter G. Wick
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The Working Party used parts of this document for…
SCENARIO ISSUES FOR DYNAMIC FINANCIAL ANALYSIS
This “chapter” was first published in 2000. It was prepared by a subcommittee of the Dynamic Financial
Analysis Committee of the Casualty Actuarial Society, under direction of the full committee. The
subcommittee was comprised of:
Glenn G. Meyers, Ph.D., leader
Gerald S. Kirschner
Charles C. Emma
Philip E. Heckman
Gerald S. Kirschner
Pierre Lepage
Eduardo P. Marchena
Glenn G. Meyers, Ph.D.
Raymond S. Nichols
Marc B. Pearl
Mark R. Shapland
William R. Van Ark
Thomas V. Warthen
Peter G. Wick
The committee was comprised of:
Charles C. Emma, chair
Donald F. Behan
Roger W. Bovard
Richard Derrig
Owen M. Gleeson
Philip E. Heckman
The Working Party used parts of this document for…
DYNAMIC FINANCIAL ANALYSIS: PERFORMANCE MEASURES, USING MODEL RESULTS
This “chapter” was first published on June 13, 2000. It was prepared by a subcommittee of the Dynamic
Financial Analysis Committee of the Casualty Actuarial Society, under direction of the full committee. The
subcommittee was comprised of:
Philip E. Heckman, leader
Manuel Almagro Jr.
Richard W. Gorvett
Richard Derrig
Owen M. Gleeson
Steven J. Groeschen
Philip E. Heckman
Betty-Jo Hill
Eduardo P. Marchena
Glenn G. Meyers, Ph.D.
Raymond S. Nichols
Marc B. Pearl
Mark R. Shapland
Peter G. Wick
The committee was comprised of:
Charles C. Emma, chair
Manuel Almagro Jr.
John G. Aquino
Donald F. Behan
Roger W. Bovard
Thomas P. Conway
The Working Party used parts of this document for…
COHERENT MEASURES OF RISK
This “chapter” was most recently updated on July 1, 2004. It was prepared by Glenn G. Meyers, Ph.D.
under direction of the Dynamic Risk Modeling Committee of the Casualty Actuarial Society. The committee
was comprised of:
Mark R. Shapland, chair
Nathan J. Babcock
Peter V. Burchett
Thomas P. Conway
Patrick J. Crowe
Karl Goring
Richard W. Gorvett
Philip E. Heckman
Larry D. Johnson
Michael R. Larsen
Glenn G. Meyers, Ph.D.
Timothy J. Pratt
James E. Rech
Chester J. Szczepanski
Run Yan
The Working Party used parts of this document for…
PRESENTING DRM RESULTS TO DECISION MAKERS: A SUMMARY REPORT
This paper was first published in the 2004 CAS Fall Forum. The report was prepared by the CAS Working
Party on Executive Level Decision Making Using DRM. The Working Party members included:
Michael R. Larsen, co-chair
Patrick J. Crowe
Casualty Actuarial Society – Dynamic Risk Modeling Handbook
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Nathan J. Babcock, co-chair
Raju Bohra
Aleksey S. Popelyukhin
Nathan Schwartz
Robert J. Walling
The Working Party used parts of this document for…
Finally, the Working Party members gratefully acknowledge the contributions and assistance of Abbe
Bensimon, Erin Clougherty and Elizabeth Smith. Abbe Bensimon… Erin Clougherty… Elizabeth Smith…
Others?
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Supplementary Material
Many of the examples in these documents have corresponding “worked” companions as part of the Public
Access Model…
Casualty Actuarial Society – Dynamic Risk Modeling Handbook
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REFERENCES & BIBLIOGRAPHY
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Insurance Company,” CAS Forum, Summer 1997, 115-134.
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Hayne, Roger M., “Modeling Parameter Uncertainty in Cash Flow Projections,” CAS Forum, Summer
1999, 133-151.
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Abbreviations and Notations
Within the Dynamic Risk Modeling Handbook documents, the following abbreviations are used:
APD, automobile physical damage
GLM, generalized linear models
CL, chain ladder
OLS, ordinary least squares
DFA, dynamic financial analysis
ERM, enterprise risk management
Within the Dynamic Risk Modeling Handbook documents, the following notation is used:
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Biographies of Working Party Members
James E. Rech is …
Run Yan is …
Amin Munza is …
Yang Bin is …
Russ Bingham is …
Peter V. Burchett is …
Steven J. Groeschen is …
Krisan Haria is …
Turab Hussain is …
Michael R. Larsen is …
Alex Lu is …
Atul Malhotra is …
Jonathan Neuberger is …
Raju Bohra is …
David Ruhm is …
Mark R. Shapland is an Actuary in Milliman, Inc.’s Milwaukee office. He is responsible for various
reserving projects including dynamic risk modeling of Asbestos Liabilities. He has a B.S. degree in Actuarial
Science from the University of Nebraska-Lincoln. He is a Fellow of the Casualty Actuarial Society, an
Associate of the Society of Actuaries and a Member of the American Academy of Actuaries. He is the current
Chair of the Dynamic Risk Modeling Committee of the CAS.
Schyler Thiessen is …
Ryan Tse is …
Xueli Wang is …
Example:
Author is assistant actuary at XYZ Insurance Company in ZZZ. She is responsible for reserving, capital
modeling, and pricing. She has a degree in English from the University of YYY. She is a Fellow of the CAS and
a Member of the American Academy of Actuaries. She participates on the CAS examination committee, and is
a frequent presenter at industry symposia. [You can include also: major work and research projects,
professional accomplishments, or extracurricular activities.]
Casualty Actuarial Society – Dynamic Risk Modeling Handbook
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Month dd, yyyy
Updates to the Handbook
The Dynamic Risk Modeling Handbook is maintained by the Casualty Actuarial Society Dynamic Risk
Modeling Committee. It represents the efforts of many people over a long period of time and has essentially
evolved into the current set of documents. As new research in the area of dynamic risk modeling emerges and
continues to evolve, the committee fully expects the handbook to evolve along with it. In addition, as the
documents are exposed to the full membership of the Casualty Actuarial Society and others who are interested
in dynamic risk modeling, comments and suggestions are also expected to arise. As such, any person with
comments or suggestions for correcting or improving the handbook, including new examples, are welcomed
and encouraged to contact the current chair of the Dynamic Risk Modeling Committee.
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Casualty Actuarial Society – Dynamic Risk Modeling Handbook